Money Market Mutual Fund Explained – Basics, Instruments, Benefits & Risk
Money Market Mutual Fund Explained - Basics, Instruments, Benefits & Risk
The debt category of mutual funds has 17 sub-categories. Mutual fund houses offer various debt fund schemes to cater to different categories of investors. Some of these include funds that focus on capital preservation (overnight, liquid, money market funds). Some funds are based on portfolio duration (low, short, medium, medium to long, long duration funds), and some funds are based on credit risk (corporate bond, credit risk funds), etc. This blog will focus on money market mutual funds – Basics, instruments, benefits & risk.
What is a money market mutual fund?
A money market mutual fund is an open-ended debt scheme investing in money market instruments having a maturity of up to one year. The objective of money market mutual funds is to invest the money collected from unitholders in short-term fixed-income securities with high credit quality and liquidity. Money market funds are suitable for investors with a conservative risk profile. The returns given by a money market fund are low because the fund manager's focus is more on capital preservation than generating returns on it.
Types of money market instruments
A fund manager invests in various money market instruments. Some of these include:
A treasury bill is a money market security issued by the Government of India. It can have a tenure ranging from 14 to 364 days. These securities are issued at a discount to face value and redeemed at face value.
Certificate of deposit (CD)
A certificate of deposit or CD is a fixed income instrument issued by banks to raise short-term money. A CD can be issued in the money market with varying maturities up to a maximum of one year.
Commercial paper (CP)
A commercial paper or CP is a fixed income instrument issued by corporations with a high credit rating to raise short-term money. A CP issued by a corporation is like a CD issued by a bank.
A repo or repurchase agreement is between two commercial banks or between a commercial bank and the RBI. The agreement is for a short-term loan against the issuance of debt security. A repo is sold at a fixed price and repurchased at a higher price at a later date. The repo rate (%) is the difference between selling and repurchase prices.
Who should invest in money market funds?
An investor with a conservative risk profile can invest in a money market fund. These investors are unwilling to take much risk and are content with low to moderate returns.
Investors looking to park their surplus money for the short-term can also invest in a money market fund. In the case of these investors, the purpose is not to generate returns but to park the money till they figure out where to invest that money for the long term.
Things to consider before investing in a money market fund
Before investing in money market funds in India, an investor should consider the following parameters:
Before investing in any financial instrument, an investor should evaluate the risk involved. In the case of money market funds, the risk involved is low as the maturity of instruments is up to one year only. However, there can still be credit risk if the security issuer defaults. There can be interest rate risk if market interest rates move up, leading to a fall in the security value.
The returns from money market funds will be low to moderate because they invest in fixed income instruments with a maturity of up to one year. They invest in instruments with high credit ratings and liquidity. Hence, the returns given by these funds are low.
Before investing in a money market fund, check the expense ratio of the scheme. The expense ratio will eat into your returns. The returns from money market instruments are already low, and the expense ratio can reduce your returns further. Hence, while investing in a money market fund, choose a fund with a low expense ratio.
Investment time horizon
You should invest in a money market fund if your investment time horizon is for the short-term. For example, if you are accumulating money for purchasing a vehicle in the next 1-3 years, you can consider investing in a money market fund. You should consider investing in a hybrid fund for a medium-term financial goal. For long-term financial goals, you should consider investing in equity mutual funds.
Taxation of money market mutual funds
Money market mutual funds are a subcategory under the broader category of debt mutual funds. Hence, money market mutual funds are taxed like any other debt fund. If you sell your money market mutual fund units within thirty-six months of purchase, the capital gain will be classified as short-term capital gain (STCG). The short-term capital gain (STCG) will be added to your overall income and taxed as per the income tax slab that you fall in.
The capital gain will be classified as long-term capital gain (LTCG) if you sell your debt mutual fund units after thirty-six months of purchase. The long-term capital gain (LTCG) tax will be levied at 20% with indexation benefit and 10% without indexation.
How to invest in a money market mutual fund?
You can invest in a money market mutual fund scheme through the Glide Invest App. You can specify your financial goal, the amount you wish to accumulate, and the investment time horizon. Based on your risk profile, the app will recommend an investment portfolio that includes money market funds.
On the Glide Invest App, you have the option to invest in money market funds directly. You can invest a lump sum or start a systematic investment plan (SIP).